Why junk bonds deliver equity-like returns but with far inferior volatility, explains Saurabh Mukherjea

They may be called "junk", but high-yield bonds have historically delivered a large part of the stock market’s returns with substantially less volatility, according to Saurabh Mukherjea of Marcellus Investment Managers.

In a newsletter, Mukherjea said US high-yield bonds have generated 70% of the S&P 500’s return since 1999, while experiencing just 58% of its volatility. The difference, he said, comes down to two basic characteristics of bonds: investors receive a regular coupon, and bondholders stand ahead of shareholders in the event of a company failure. That combination has allowed junk bonds to participate in market rallies while cushioning losses when equities come under pressure.

What exactly is a junk bond?

At its simplest, a bond is a loan to a company. An investor lends $100, receives interest through the life of the bond and gets the $100 principal back at maturity. Rating agencies such as S&P and Moody’s assess the company’s ability to repay that debt, with ratings ranging from AAA to D, which denotes default.


The dividing line is BBB. Bonds rated BBB– or higher are investment grade, while those below it are classified as high yield, or junk.

The term itself goes back to Wall Street in the 1980s, when Michael Milken built a market for bonds issued by companies that major banks were unwilling to finance. Mukherjea said the label is misleading because "junk" does not mean worthless. Instead, it refers to companies that have to pay more to borrow because they are smaller, carry more debt or are facing a difficult period.

There is also a category known as fallen angels. These are bonds that began life with investment-grade ratings but were subsequently downgraded.

Equity-style returns with far less volatility

The long-term numbers highlight why Mukherjea sees high yield as distinct from its unflattering name. Between January 1999 and September 2026, the ICE BofA US High Yield Index delivered an annualised return of 6.2%, compared with 8.8% for the S&P 500. In other words, high yield captured 70% of the stock market’s return over the period.

The volatility gap was much wider. High-yield volatility stood at 8.7%, compared with 15% for the S&P 500. That means investors received about a fifth more return for every unit of risk taken, based on the figures cited by Mukherjea.

The coupon is a major part of the equation. US high-yield bonds currently yield close to 8% a year, and over longer periods, coupon income rather than price gains has accounted for almost all of the return. That income continues to accrue unless the issuer defaults, helping support returns even when markets are under stress.

The other difference lies in the order of repayment. When a company fails, bondholders are paid before shareholders.

The performance of junk bonds during major market shocks illustrates the point. During the dot-com bust, US stocks fell 42.5%, while junk bonds gained 1%. In the global financial crisis, stocks dropped 50.9%, compared with a 26.5% fall for junk bonds. During the COVID crash, the declines were 19.6% and 13.1%, respectively.

And when markets recovered, high yield participated strongly. The asset class returned 57.5% in 2009, more than double the S&P 500’s 26.5% gain.

Junk bonds work best as part of a team

Mukherjea's argument, however, is not that high yield should replace equities or other assets. High yield remains tied to the financial health of companies, and its performance can suffer during a deep recession, as the experience of previous crises shows. The broader case, he said, lies in combining assets whose performance does not move together.

Disclaimer: This article has been written by Veer Sharma, who is not a SEBI-registered Research Analyst or an Investment Adviser. Veer Sharma and his ‘relative(s)’ (as defined under Section 2(77) of the Companies Act, 2013) do not hold any financial interest in the companies mentioned in this article as of the date of publication. The views/recommendations mentioned in this article, wherever applicable, are those of the respective SEBI-registered Research Analyst/brokerage and have been reproduced/reported with due attribution. They should not be construed as the views or recommendations of The Economic Times Digital or the journalist. Readers are advised to consider the original research report and make their investment decisions based on their own assessment. Brokerage disclaimers here.